Rally to be capped at 5-10% from current level: Religare MF

The week gone by saw Indian equities surging past resistance levels to end on a high note. However, chief investment officer at Religare Mutual Fund, Vetri Subramaniam expects this rally to be capped at 5-10% higher from current levels. Global factors off late have been conducive for a rally, but domestic macro continues to be a significant concern, he explains in an interview to CNBC-TV18.

Subramanium goes on to say that he expects the market to remain volatile within a trading range. Therefore, avoid sectoral calls and focus on stock picking, he said, adding that companies with a high return on equity (RoE) will trade at a premium.

He further adds that poor domestic environment could lead to a cut in earnings estimates for FY13.

Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee.

Q: Do you think what we are witnessing right now is a technical rally or have fundamentals changed around to justify higher prices?

A: It’s always hard to separate the factors because a little bit of everything goes in for the market at this point of time. A little bit of optimism coming in from the way global markets and risk assets have performed and some good economic data or I would say not very bad economic data out of the US, so global factors have been conducive for a rally.

The earnings picture locally has been reasonable too, nothing very dramatic. There have been a few surprises on the negative side, but equally we have seen few companies do quite well. So the earnings season has played out reasonably okay so far. So all of that put together, the market had a big of headroom in terms of valuations to put in a bit of rally and that’s what we have seen.

Q: Does the combination amount to an extension of the rally or would you say this is about it?

A: I think purely from a valuation standpoint at one point we had gone down to almost about 18-20% below our historical trading multiples so there still may be about 7-8% below historical trading multiple averages of about 17 times odd. So there may be a bit more room to the upside. But where I would start to worry is the fact that as far as the domestic economy is concerned things are looking quite poor at this point of time and the risk is that we actually see further slackening of GDP growth in FY13.

Q: You were saying that growth might slow down in FY13, so where do you think that market gets capped given the outlook on domestic macro?

A: I would say another 5-10% from here. I think the adverse domestic macro will come back to haunt us and I would split with the camp which seems to attribute all the problems that the Indian market has had this year with global events. I think our biggest challenge is our domestic issues; the global issues are only clouding the domestic picture. The investment cycle has pretty much stalled at this point of time and I worry that unless we see a significant pick up in investments, it is pretty much a given that growth will come in below 7% in FY13.

So I think it really is the domestic factors which are front and center as far as we are concerned. The global issues obviously create a lot of volatility, but it is the domestic factors that I would worry about.

Q: In the immediate term do you feel that this rally has the power to surprise on the upside because of how cramped the market has been through all of this year. Can we go much further than people expect?

A: You cannot rule it out because at the margin there has been a lot of money sloshing around, not just in India but all over the world, which is risk on-risk off. We are seeing money gushing through all sort of financial markets and asset classes and in that environment it’s interesting that markets like India are now the low beta market around the world. It’s the newest market and markets of Europe which are the high beta markets and that’s visible in the way those markets have behaved during the course of this year.

So we are in some senses strangely a low beta play in the global environment right now, but we will catch a little bit of the tailwind if it continues to remain supportive in Europe and US. But eventually, our fate will be determined more by local factors. We keep talking about the global slowdown but at the same time we focus a lot more on the domestic growth story and it is that domestic growth story which is starting to creek at this point.

Q: So what is your best case prognosis for the next few quarters? Do you think the market will grind in a bit of a range with occasional bouts of volatility or do you see a more constructive uptrend starting next year?

A: It all depends on when the uptrend will come but I think in this kind of an environment the scope for a further de-rating of the markets is certainly there. There will be pressure on equity prices coming from the fact that earnings estimate for 2013 definitely need to be cut. I am seeing consensus numbers in the region of 20% earnings growth for FY13 and I don’t think those are going to come through when you got GDP growth slowing down to below 7%. I think there is a lot of earnings cuts which will come through.

Secondly, as far as PE multiples are concerned, the risk to derating is going to come both through the fact that our growth is slowing and secondly from the fact that you have got 10 year bond yield now pushing close to 9%. So both these things put together clearly make for the case that equities will continue to de-rate. So you will see 10-12% earnings growth but some of that will get offset by the fact that PE multiples will de-rate.

Q: In that case, do you think the downside is protected around those 4,700 Nifty kind of levels where we seem to be bouncing off every time in terms of valuations as we get forward in time or do you think those levels could be at risk as well next year?

A: I think if you look at the risk that could cause us to go down even below that in retrospect might then create a good buying opportunity. But if you have the ten year bond yield going north of 9%, which would be largely a function of fiscal profligacy in Delhi and not so much of a function of RBI rate action, then there is a risk of this market eventually breaking down below what has been fairly critical shelf of support that we have seen through this year.

I think that would be driven both by the slowdown in GDP growth that I am talking about as well as by spike up in the ten year bond yield. If those two factors come about then there is risk that the market will trade lower and will trade through that support.

Q: Going into next year is there a case for the tact to be turned around in terms of what the approach should be for defensives and high beta?

A: It has been a very interesting environment from our perspective. There have been some sectors which have been less affected by the macro headwinds and some which have been more adversely affected. But when we drill it down, what we are finding is that there is a lot more value addition that is coming to the portfolio by way of alpha creation from stock selection rather than just focusing purely on the sector selection. Really the call that we have to take as portfolio managers at this point of time and the way at least we are approaching it is to be driven a lot more by the credentials of the companies rather than just getting blindly attached to certain sectors or avoiding certain sectors.

In sectors that tailwinds are favorable or at least the scene has been in some cases perhaps defensive, valuations already captured or factor in a lot of the attractiveness of those companies. Where as in other areas where the macro headwinds are adverse, there are companies where there could be continued to be short term issues but the valuations are favorable if you are willing to stay the course with them over a period of time and wait for the environment to turn more conducive.

I would really say this is an environment where you need to focus a lot more on the stock picking bit. Yes, sector selection is important but the stock picking is going to be far more important, both in terms of limiting your downsides and preparing yourself for some kind of cyclical upside which might play out sometime in 2012. So if you want to position yourself in both of these, I think stock selection is going to be far more important that the sector selection.

Source: http://www.moneycontrol.com/news/mf-interview/rally-to-be-capped-at-5-10current-level-religare-mf_607673.html